Investors need to manage their portfolios in a way that capitalizes on opportunities while mitigating risks, advises Andrew Mehalko, Chief Investment Officer at GenSpring Family Offices. The portfolio should be exposed to different risk factors to avoid situations of having too many investments underperforming at the same time. A speaker at the marcus evans Alternative Investments North America Summit Fall 2010, taking place in Las Vegas, Nevada, October 14-16, Mehalko discusses risk mitigation strategies, attractive investment opportunities and his outlook for the future.

What risk mitigation strategies would you recommend?

Andrew Mehalko: With our families, we feel that it is important to manage portfolios to defend against permanent capital loss. Managers must be combined in such a way that when one does underperform, it will not have a significant effect on the portfolio. Exposure to other managers utilizing different strategies and taking different risks will in turn balance out the portfolio. This mix lessens the risk of the portfolio being caught in an unstable position.

What are some of the investment opportunities or untapped areas in this asset class?

Andrew Mehalko: GenSpring does not consider alternative assets as a separate class. Remember, these are professionals who are looking to invest in the capital structure of a business or a government and using various tools to either leverage that investment or hedge against risks. These managers are often investing in equities, bonds, or other securities within the capital structure, which is why we do not view alternative assets as a separate asset class.

Investing opportunities occasionally come about through dislocations in the capital markets. For example, there were areas in the credit space that were attractive after the crisis from a risk-adjusted perspective.

Mortgage backed securities currently have some potential, though they have performed well over the last 18 months. Today, there are very few natural buyers of these complex structures and many sellers. When looking at the risk characteristics of the underlying assets, we believe prices for certain pools of assets have become attractive.

We also believe global trading is underutilized at the moment; if you look at the distribution of assets across alternatives, this area is very low as a percentage of the total assets of alternative investments. It has always been a key core position for our families’ portfolios, to a much greater degree than you would find in the distribution of alternative assets by strategy. It can be considered untapped in the sense that others do not weigh it appropriately in their portfolios.

What is your outlook for the coming few years?

Andrew Mehalko: We have not had to worry about high inflation or deflation for many years; we have had moderate inflation and a reasonable return on capital. Now, for the first time in my career, deflation and high inflation are significant tail risks. Very few financial assets would work in those environments, which is why no investor or government wants to see either scenario happen.

However, there is a risk that governments are unable to control inflation to the degree they want. If they are aiming to manage inflation at 2.5 or 3 per cent per year, there is a chance – and history has proven this – they will have a difficult time accomplishing this. If inflation goes above 3.5 to 4 per cent, or even 5 to 7 per cent, that can cut purchasing power which would be devastating for a wealthy family or any family for that matter. Therefore, investors need to manage those two risks.

Our asset allocation advice for families is to have enough exposure in a dynamic way; exposure which can be adjusted quickly to protect capital and profit in deflationary or inflationary periods. We have tried to make sure that we cover the two distributions but still be exposed to different risk factors that can give returns in challenging environments, which is what we expect for the next few years.

What long-term investment strategies would you recommend?

Andrew Mehalko: We need to be accommodating of risks, but also remember that we are managing money for multiple generations, so it is okay to take risks. We actually have to take risks! We recommend that families invest in good public and private companies – at the right valuations, with good earning expectations, strong balance sheets, good management and solid prospects for the future. The private side gives the kind of illiquidity premium which the investor will eventually get paid for. A multi-generational family need not worry as much about liquidity, but it is always good to have both public and private positions. Wealthy families should maintain positions in long-short equities and global trading.

A combination of these three should be in everyone’s portfolios for the long term as they will work at different times. We do not want to rely on a good equity or fixed income market; we want to be able to help families attain their specific and unique goals, regardless of what is happening in the current environment. It is very important to put that in context, and make sure that the solutions that we come up with are all working towards our families’ goals.

About Alex Akesson

Alex has been specializing in hedge fund and alternative investment news since April 2006. Working mainly in research and manager interviews, she has published breaking news on the hedge fund industry on her blog, as well as several industry publications.
Her access to hedge fund managers gives her insight into news stories as well, and the ability to track press releases and other breaking news in real time.